May 2017 – Volume 1, Issue 3
Venture Capital in 2017: What’s Next?
What Happened in 2016?
Despite a strong start to 2016, global venture capital funding began to dry up towards the end of Q3. Between the U.S. election and Brexit, high uncertainty drove investors to tighten their belts and prepare for the worst. All in all, 2016 had a 24% decrease in deal flow over the previous year; in other words, a difficult year for our friends in Silicon Valley. Regardless of the low deal flow, however, the total amount of capital raised in 2016 (126.4Bn) remained relatively high especially when compared with the recording breaking numbers of 2015 (140.6Bn). This phenomenon was driven by investors putting more capital into fewer firms that were already proven to be profitable. Facing a slow-down of investor activity, 2016 also saw the government playing an increasing role in the VC industry. In particular, the U.K. government announced 1Bn Pounds for the development of UK-based technology start-ups. Not to be out-done, Germany and France combined forces to create a 1Bn Euro fund also for tech-based start-ups. This is a highly positive trend that bodes well for the continued global support of entrepreneurs and tech innovation.
Early Trends in 2017
Although 2016 was racked with uncertainty, 2017 has started strongly with corporations leading the charge. Corporate venture capital investments have historically made up a significant portion of total VC activity and 2017 is no exception. In addition to committing funds to start-ups external to the company, an increasing number of corporations are developing internal business accelerators or “innovation labs” as they’re commonly referred to. These intrapreneurial endeavors give young visionaries an extraordinary opportunity to experiment. Without the resource constraints of a regular start-up, innovation labs are a perfect place to beta-test and commercialize great ideas.
Another emerging trend in 2017 reveals that finding deals for good value is getting more challenging for investors. As valuations continue to inflate (Uber is now valued higher than General Motors), it’s becoming increasingly difficult for VC firms to achieve their target returns on equity. In some respects, this has contributed to increasing competitive rivalry amongst venture capital firms. A symptom of that rivalry has been an increase in firms seeking investment opportunities at start-ups in earlier stages – everybody’s money is green and fewer bids can mean better value. Investing at an earlier stage, however, is not without its risks. The tasty valuations of early stage firms are likely to come with untested products, unproven models, less experienced teams or some combination of the three. This forces more investors to make challenging trade-offs between higher uncertainty and better value for their dollars. This trade-off is demonstrated by the median deal size of seed, early and late stage funding rounds. While late stage funding rounds remain the largest by far, the median deal size of late stage rounds has declined by 16.7% over the past year. Over the same period, the median sizes of earlier rounds of funding have increased by a similar proportion. Venture capitalists are no strangers to the earlier stage risk/reward trade-off and will continue making big bets in 2017 provided that the economic backdrop remains supportive.
Another noteworthy trend that is likely to continue through 2017 is the increasing importance of Canada on the global VC stage. Canada’s VC market can be described as young but maturing and is becoming increasingly more attractive to US investors. Canada’s global relevance is best illustrated by the landmark deals that have been completed most recently such as the 225m Series A raise by Toronto-based BlueRock Therapies backed by Bayer and Versant Ventures. Another notable Canadian deal was the funding round (amount undisclosed) by Hubba Inc. which was backed by Goldman Sachs. These deals in particular are hard evidence that American investors are warming up to the idea of Canadian-based start-ups which bodes well for the Canadian economy as whole.
In sum, VC sentiment is cautiously optimistic so far in 2017. Political and market activity are showing signs of leveling out after a choppy 2016 and investors are poised to make their move. Macro conditions are also more favorable for VCs heading into 2017 than they were in 2016. Strong economic indicators like job and real wage growth should give investors’ confidence in the near-term and the recent Federal Reserve interest rate move should help foster a more optimistic sentiment moving forward. Another positive sign for VC activity in 2017 is a strong opening to the IPO market. 4Bn worth of IPOs, a very high number relative to previous years, has already been announced in 2017. Even though the Snapchat IPO makes up a majority of that number at 3.4Bn, the total is still impressive without it. Looking towards the remainder of 2017, KPMG expects that Healthcare, AI, IoT and Cloud computing will be the driving sectors for venture capital activity. This is primarily due to stabilizing regulatory uncertainties in the US and the high pace of innovation often seen in these sectors. In terms of key trends, expect earlier stages of funding to continue getting more attention from investors and expect corporations to want a bigger chunk of the VC action. Lastly, expect governments to continue playing a major role in start-up funding, particularly in the tech sector